What is the 4% Rule and How Can It Help You Save for Retirement?

Finance

What is the 4% Rule and How Can It Help You Save for Retirement?

That’s a rather daunting task for someone just starting out in their career. Advisory services are provided for a fee by Empower Advisory Group, LLC (“EAG”). EAG is a registered investment adviser with the Securities and Exchange Commission (“SEC”) and subsidiary of Empower Annuity Insurance Company of America. Registration does not imply a certain level of skill or training. Assuming a 6% rate of return and the $1.25 million figure from our earlier example, you would need to save about $218,000 over 30 years to reach this hypothetical retirement goal. If you have a better idea on what your annual expenses might be in retirement, you can create a more personalized goal for yourself using the 25x rule. Estimate your annual expenses in retirement and multiply that figure by 25.

According to a 2022 Gallup survey, the mean age for retirees in the US is 61. If you were to live to 85, this means you’d need enough money to cover all your expenses (and retirement goals) for at least 23 years.

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Defining your retirement need requires that you have a retirement age in mind and a basic understanding of what your spending needs will be during your retirement years. A simple approach for defining your retirement
needs is based on using a percentage of your current income, adjusted for inflation between now and when you retire. You might also want to consider how your salary will change based on merit or cost of living increases.

Saving Tip #1: Cut Down Your Cost of Living

Look at your most recent estimate—available on the  Social Security websiteOpens in a new window —to determine your approximate benefit, and have your spouse or partner do the same. Keep in mind the amount of your monthly payout will depend heavily on when you start claiming your benefit—in general, the longer you wait, the larger your monthly payment. Additionally, Social Security is one of the few resources that provides regular cost-of-living adjustments.

At some point, other uses for your money will probably start to compete for your attention. But keep in mind that as far as financial goals go, experts agree that saving for retirement should be number one. For example, see whether your workplace plan offers “step up” contributions, which automatically increase your savings percentage once a year until you reach your target. Wherever you are in life, our retirement planning tools can help you feel confident and prepared for the future. Expanding your family or preparing for another large life event can quickly change your budget. To plan ahead, Klein recommends contributing as much as you can to your 401(k) pre life event. The logic behind this is that you not only increase your retirement fund, but also learn to live on less.

Create a savings goal—and go for it

An increasing number of large, national, well-known (they advertise on TV) brokerage and mutual fund firms are willing to open small accounts without fees or minimums. They often have a wide selection of investment options (mutual funds, exchange-traded funds, or ETFs) and the most transparent and reasonable fees. And once you open and fund your account, you’ll need to pick your investments. The 4% rule and the updated 3.3% rule are actually rules of thumb for how you should spend money in retirement, not explicitly how to save for it. However, having an idea of how much money you’re going to spend in your non-working years can help you work backward to figure out how much you’ll need to have saved up in the first place. As a result, many financial planners now believe that 3.3% may be a more comfortable amount to withdraw each year.

If you’re not yet saving as much as you’d like, you can increase your contribution rate over time, or when your budget allows. While there are no shortcuts to a secure retirement, investing in your retirement plan means you’re on the right path. In addition, you should be saving money in a retirement account, such as an IRA, which is offered by brokerages like Charles Schwab. These accounts offer tax benefits and encourage you to leave your funds untouched by imposing early withdrawal penalty fees should you tap into your earnings before age 59 and a half. Read more about 403b vs 401k here. The above savings guidelines include anything you have in a retirement account, like a 401(k) or Roth IRA, company matches, as well as your investments in things like index funds or through robo-advisers. While personal savings goals can differ between individuals, these milestones can help you stay on track or kick it into gear if you’re nowhere close.

You make $100,000 and you’ve already decided to keep working until you hit 70. After thinking it over, you decide that you would be comfortable living a lifestyle at 70% of your current salary ($35,000) in retirement. Assuming a rate of return on your investments around 4%, you would have to save about $189 per month from now until you turn 67 to retire with a minimal surplus of $2,042. If you continue on your current path of saving only $100, however, you’ll be over $310,677 short of your retirement goal when the time comes. Assumes a constant asset allocation, a 75% confidence level, and withdrawals growing by a constant 2.53% over 30 years. Confidence level is defined as the number of times the portfolio ended with a balance greater than zero.

Similarly, many companies will also contribute funds if an employee contributes to a retirement account. An employer’s contribution amounts to free money, and most financial advisors would encourage their clients to maximize this opportunity. It is also important to note that the government (and many businesses) offers incentives to save. Based on historical data, living off of just 4% will allow you to use your retirement portfolio to cover expenses for 30 years. Whether you plan to live lavishly or frugally, you’ll need to have a certain amount of money saved by the time you retire. Think of this figure as a mountain summit, reachable by several different paths.

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